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Global Government Bond Yields Slide as Rout Stalls

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November 22, 2016

By Min Zeng

Government bonds on both sides of the Atlantic strengthened on Tuesday, showing tentative signs of stabilizing following relentless selling pressure driven by hopes of expansive fiscal policy from the new U.S. administration.

The yield on the benchmark 10-year Treasury note was 2.316%, according to Tradeweb, compared with 2.335% Monday and a 12-month high of 2.337% Friday. Yields fall as bond prices rise.

The yield on the German bund fell to 0.242% and the 10-year U.K. gilt declined to 1.385%. The 10-year yields in Italy, Spain, Portugal, Denmark and Sweden also fell.

Some investors deem the selloff since the Nov. 8election as overdone, and they are finding these yields attractive. The 10-year Treasury yield logged the biggest rise in 15 years during the past two weeks.

The bond market rout "happened in a short amount of time and will likely take a break at these yield levels waiting for global data and direction, " said Sean Simko, head of fixed-income management at SEI Investments.

Also soothing some anxiety in the bond market: Two top officials at the European Central Bank, including ECB President Mario Draghi, signaled a firm commitment to providing monetary stimulus as they are still struggling to push up inflation toward the ECB's desired target. Some economists expect the ECB to extend its bond buying program at a policy meeting in December.

Analysts caution that the bond market is prone to renewed selling pressure.

Appetite to hold government bonds has diminished due to the prospect of large deficit spending, lower taxes andlighter regulation advocated by U.S. President-elect Donald Trump. Many investors are concerned that this policy outlook will boost U.S. growth, lift inflation and lead to a faster pace of interest rate increases by the Federal Reserve than many investors currently anticipate.

Inflation chips away bonds' fixed returns over time and is the big threat to the value of long-term government debt. Global data over the past two months have been showing upticks in inflation. A gauge of inflation expectation in the U.S. bond market has been rising closer to the Fed's 2% target.

These developments are pushing investors to reassess the bond market outlook. Some are starting to wonder whether the bond market is pivoting away from its 35-year-old cycle of lower bond yields.

The key factors driving bond yields to historical lows had been expectation of low growth, tame inflation and ultra loose monetary stimulus among major central banks. Concerns have been growing over the past two months that major central banks' monetary stimulus are reaching limits with fiscal policy likely to take a bigger role in 2017 for global policy makers to combat sluggish growth.

Some traders expect the 10-year Treasury yield potentially rise to somewhere between 2.5% and 2.75% before the end of this year.

Expectation has been growing that the Fed would raise rates next month and potentially tighten policy at a faster pace than many investors anticipate. This factor has been hurting demand for short-term Treasury debt lately, as yields are highly sensitive to the Fed's policy outlook.

The yield on the two-year Treasury note reached 1.107% earlier Tuesday, the highest intraday level since April 2010, according to Tradeweb. The yield was recently at 1.099%, compared with 1.084% Monday.

As investors shed holdings of short-term debt to prepare for higher interest rate policy from the Fed, they are migrating the cash into long-term Treasury bonds, which contributed to the declines in their yields Tuesday, said traders.

Fed fund futures, another derivative markets for investors to place bets on the Fed's policy outlook, showed the odds for the Fed to raise rates by the Dec. 13-14 policy meeting were 100% Tuesday, according to data from CME Group. The odds were 12% in late June when many investors cast doubt over the Fed's capability to raise rates this year following the Brexit vote.

New debt sales concentrate on short-term maturities this week, which also drove investors to sell short-term debt and buy long-term bonds.

A $34 billion sale of five-year Treasury notes is due at 1 p.m. Tuesday, followed by $28 billion of seven-year notes Wednesday. The bond market will be closed on Thursday for Thanksgiving.